How the Three Arrows Collapse Changed Ethereum DeFi Lending

Decentralized finance (DeFi) lending has changed—especially following the collapse of major companies like Three Arrows Capital (3AC) last year—and managing risk is now key for the industry’s success, according to Maple Finance CEO Sidney Powell. 

Powell, who co-founded DeFi lender Maple Finance, told Decrypt at Messari Mainnet 2023 this week that the DeFi lending space has matured over the past year. Not that it’s had much choice. The implosion of crypto hedge fund 3AC in June 2022, and the contagion that has spread throughout the market since, has forced traders and lenders to reevaluate what is realistically possible.

“Borrowers and lenders are now saying, ‘I’d rather take a pretty sure 8% [return], rather than a speculative 20%’,” said Powell. “So we’re seeing much more emphasis on what is the risk-adjusted yield rather than what is the absolute yield,” he added.

Yield in DeFi and traditional finance refers to cash earned on an investment over time. In the experimental world of DeFi, investors can lock-up funds and earn rewards.

A little over a year ago, crypto lenders were still promising borrowers astronomical returns on deposits, in some cases over 20%. But those days are now over, in large part due to the collapse of the crypto project Terra in May of last year.

Terra in its hey-day was a massive ecosystem with lots of apps largely focused on algorithmic stablecoins. At one point, it was perhaps the most talked-about DeFi blockchain and the second biggest after Ethereum; its native cryptocurrency, LUNA, was in its prime one of the top biggest digital assets by market cap. 

Terra’s most popular app, Anchor, facilitated risky lending and borrowing and enabled crypto degens to deposit Terra’s UST stablecoin and at times earn in excess of 20% returns in the form of more UST.

But when the music finally stopped, Terra imploded, taking hedge funds that were invested in the project down along with it.

Singapore-based cryptocurrency hedge fund 3AC was just one firm hit hard by the chaos. The firm promised big things to clients wanting to invest in new digital asset ventures. And to do so, it used crypto lenders promising big returns. 

Following Terra’s blow-up and the subsequent plunge in crypto prices, 3AC filed for bankruptcy—leaving many crypto lenders waiting on their cash. 

Now, says Powell, crypto lenders are much more sensitive to “counterparty risk management.” 

“The lessons taken away [from the collapse of 3AC] are counterparty risk management, managing contagion, and kind of siloing the risk to the individual borrowers that a lender is facing,” he said. 

He added that “seeing what is happening with funds” is now necessary so lenders can control it and a borrower cannot “trade itself into insolvency like 3AC did.” 

Maple Finance is a credit marketplace which helps provide loans to institutions. It stands out in the DeFi space because it provides undercollateralized loans and puts them “on chain.”

Following the collapse of major crypto lenders, Maple in June launched a direct lending desk, Maple Direct, offering overcollaterized loans.  

Powell also told Decrypt at Mainnet that debt is a better asset to tokenize than equities. 

He said that this is because it is easier to monitor, while equity is difficult to track on-chain, in part due to its “changing valuation” and difficulty to track cash flows.